Wednesday, November 25, 2015

Canada Need Not Fear Deficit Financing

As the new Liberal Government takes shape, all eyes will be focussed on how it proposes to finance its ambitious agenda . Deficit financing will be at the centre of all discussions concerning jobs and economic growth over the next five years. In its latest Economic and Fiscal Update (November, 2015), Canada's Finance Department recognizes the damage that has already occurred from plunging commodity prices, the deterioration in the country's terms of trade and the worldwide slowdown . The major question facing the Government is : to what extent can it undertake deficit financing to achieve its economic goals.? What is the capacity of the Federal finances to meet this challenge? Fiscal Outlook Table 1 is a summary of the fiscal outlook to financial year 2021 prepared by Finance Canada, the department responsible for the national budget. Their budget projections used the former
(Harper) government’s 2015 fiscal framework , updated to November, 2015. None of the new government's revenue or expenditure programs are included.

Table 1 Fiscal Outlook

A couple key metrics standout. First, over the next three years ( 2016-19) the Federal deficit will average 0.1% of GDP--- well within a comfort zone and not out of line historically. Expected economic growth, although modest over the next 5 years, will likely provide sufficient revenues to absorb the annual deficits so that the level of Federal debt at the end of period remains largely unchanged.Second, the Federal debt as a percent of GDP actually falls from 31% in 2015/16 to 25.2% by 2020/21. Comparing these levels of debt/GDP , the levels represent the lowest in over 30 years, especially in periods of good economic growth in the latter half of the 1990s. ( see Chart 1). .Chart 1 Federal Debt as % of GDP Canada has always been well-received in the capital markets at home and abroad ; bond auctions continue to be well covered and receive firm bids. More importantly, as Chart 2 demonstrates, the entire Canadian government yield curve has shifted downwards , a reflection of low inflation expectations and confidence in the quality of the security sold. Of late, there has been shift towards issuing longer dated bonds to take advantage of the falling long term rates ( 10-30 year terms). Accordingly, the weighted average rate of interest on public market debt has fallen to 2.37 per cent in 2013–14 ; this average rate , now stands above the current yield for bonds 10years and up. Any additional long-term issuance will contribute to a reduction in
refinancing risk at a low cost .Chart 2The IMF refers to 'fiscal space' as " the room in a government's that allows it toprovide resources for a desire purpose without jeopardizing the sustainability of its financial position" . Canada is in no way jeopardizing the Federal budget , given the low interest rate environment.
More importantly, should the fiscal restraints be relaxed to accommodate additional borrowing aimed at developing infrastructure projects, these projects can pay for themselves over the longer term.

Comparison to US Stimulus Programs Parliament opens the first week of December at which time Canadians will learn more of the programs and policies that will constitute the Federal budget and hence the anticipated future deficits. At this point we can assume that the Liberal's platform , featuring infrastructure spending, individual spending programs, and tax changes aimed at the redistribution of income will be at the centre of the next Federal budget. The platform anticipates a budget deficit not to exceed $10 billion in any year. American readers should note that what is proposed by the Canadian government is quite different from the American Recovery and Reinvestment Act, 2009( Stimulus Bill ) . That bill was designed as an emergency measure to kick start the US economy after the financial crisis of 2008. The main thrust was tax relief for the individuals and corporations to save and create new jobs; a much small component included spending on new infrastructure . A secondary goal was to provide immediate relief to those state and local governments hardest hit by the steep recession.